Experimentation Can Drive Expansion into Underserved Markets

By Jennifer Tescher and Katy Jacob

Front-line focus on cross-selling and customer retention poses the question: what part of pay should be at risk?

|SYNOPSIS| Stored value cards (SVCs) are often thought of as a niche product for “under-banked” or nonbank customers. Yet The Center for Financial Services Innovation (CFSI), advocates for the underbanked, argues that there’s more to the story. General purpose SVCs offer more functionality than payroll or gift cards, providing customers with the ability to load funds and make purchases in a variety of manners and locations. Banks have much to learn from the example of alternative providers that have built business models, IT systems and distribution channels around SVC transactions and the fee income they generate, the CFSI says. Pricing structures and approaches abound but early entrants agree: Profitability requires scale.

Alternative financial services providers tout stored value cards (SVCs) as the “un-bank account” to lure underbanked consumers who are turned off by — or have been turned away from — traditional banks. But as banks focus on the potential value of underbanked consumers, they are finding that SVCs can be a potent tool to initiate, extend and enrich their customer relationships, transforming SVCs from a niche product into one with broader appeal.

Of all the stored value card products on the market today, general purpose SVCs look most like traditional bank accounts in that they accept a broader range of deposits and offer greater functionality than payroll or gift cards. Consumers can load funds on the cards and make purchases in a variety of ways and at a range of locations. They can withdraw cash or pay bills, and have funds directly debited on a recurring basis. They can purchase a second card and use it to send money around the globe. As a result, general purpose SVCs hold tremendous potential for banks in further automating transactions, reducing costs and appealing to a new customer base.

A series of reports on the SVC industry by the Center for Financial Services Innovation (CFSI) finds that, while still small overall, the SVC market has mushroomed in the last few years. Of the $157 billion loaded onto all prepaid products in 2003, Mercator Advisory Group estimates that general purpose SVCs accounted for 15%, or $23.5 billion. According to The Pelorus Group, approximately 15 million prepaid debit cards have been issued, including payroll cards, and that figure is projected to rise to 34 million in 2005, with general purpose cards accounting for 35%, or 12 million cards. Meanwhile, MasterCard reports that they have more than 200 SVC programs of different types with 100 issuers; the company has seen double-digit increases in relationships with third parties and SVC processors in the last few years.

ALTERNATIVE PROVIDERS

Today, alternative providers such as NetSpend, which distributes its All-Access cards in check casher and grocery store chains, and NextEstate, whose GreenDot cards can be found primarily in grocery stores and pharmacies, dominate the general spend portion of the market. In the past year alone, NetSpend’s 700,000 cardholders have loaded in excess of $1 billion in funds onto their cards.

Once consumers purchase a NetSpend card, the company communicates intensively with them to sell bill payment, direct deposit, interest-bearing saving accounts and other features that make the card more valuable and keep the customers coming back for more. (The company works with several regional banks that serve as issuers of the NetSpend card and hold the corresponding funds, including Inter National Bank in Texas and BankFIRST in South Dakota. NetSpend cards issued by Inter National Bank are FDIC-insured at the individual account level.)

Early indications are that most SVC users either do not have a bank account or have a limited banking relationship. Alternative providers are capitalizing on that in their marketing campaigns. Unlike many banks, they view underbanked consumers as valuable and desirable. Their business models, IT systems and distribution channels are built around transactions and the fee income they generate, and this approach resonates with their customers’ lifestyles. Banks are starting to discover that this can be true for them, as well.

The underbanked market represents a vast, untapped source of new customers and revenues. While as many as 22 million American households have no banking relationship, millions more have a bank account but continue to use alternative providers to meet many of their financial needs. Though underbanked consumers are far from monolithic in their demographics and preferences, underbanked consumers are more likely to be ethnic minorities and tend to be both time- and cash-constrained.

MARKET POTENTIAL

The market potential is significant. According to a 2001 Fannie Mae Foundation report, alternative providers processed roughly 280 million transactions a year, accounting for $78 billion in revenues. The number of alternative financial service outlets in the U.S. continues to grow.

The question for banks is how to address the concerns of underbanked consumers and provide them with products that meet their needs within the context of the banking environment. The promise of SVCs is that they can provide a means to address would-be bank customer needs and, at the same time, consumer concerns, while lowering costs for the bank and creating products that appeal to a broad range of customer segments.

How do SVCs do this? SVCs generally lack the identification and credit requirements that effectively bar millions of individuals — including even well-established immigrants — from opening traditional bank accounts.

SVCs can be purchased and reloaded at a growing number of locations other than bank branches, such as check cashers, convenience stores, and other retailers — an important consideration for the broad range of customers who are motivated by comfort or convenience, including young and mobile professionals. SVCs can provide immediate availability of funds at a cost that is lower than some alternatives, such as check cashers. Underbanked consumers are more likely to live from one paycheck to the next; easy, immediate access is crucial.

SVCs are prepaid, and more difficult to overdraft. This works to the long-term benefit of both the consumer and the bank. Underbanked consumers are not price-sensitive in the typical sense, but they do prefer to know about and pay for fees up front rather than incur them unexpectedly. They pay a premium to alternative providers for such fee transparency. Most NetSpend customers, for instance, have chosen a monthly fee plan that provides an unlimited number of purchase transactions for $9.95.

Innovative alternative providers are responding to this customer segment in surprising ways. For instance, NetSpend offers cell phone text messaging to help consumers keep track of card balances, providing real-time information so they can make informed purchasing decisions. That single feature speaks volumes about the potential financial power and sophistication of these often overlooked consumers.

EARLY BANK EXAMPLES

For their part, the banks that have gotten into the SVC game are adopting their own unique approaches. Some banks have chosen to play the role of issuer for products distributed by other providers. BankFirst, a South Dakota-based bank with more than $700 million in assets, issues cards for numerous third-party prepaid programs through its payment systems business. This strategy makes sense for banks with limited retail presence because the customer relationship resides with the distributor, as does the rest of that customer’s share of wallet.

Central Bank of Kansas City is a community bank that’s willing to work differently to earn business from a different segment. Staff has taken to bringing a PalmPilot or laptop with the SVC platform loaded on it to sell cards to the day laborers who congregate under the overpass near one of its branches. The bank recently began an SVC pilot that encourages customers to reload their cards at the teller window at one of its eight branches, and uses the opportunity to cross-sell other products. The Dinero Seguro card costs $5; reloads cost $2.50. The bank plans to leverage SVC usage into checking and savings accounts, consumer loans and ultimately mortgages.

“Dinero Seguro allows us to respond to an unmet need in the underbanked market,” says Tom Lilley, chief financial officer of the $133 million bank. “The product provides customers a new way to interface with the bank. It’s not about replacing checking accounts. It’s a steppingstone for consumers to start a bank relationship with us that lets them know that Central Bank of Kansas City wants their business.” One of the most recent bank entrants into the SVC market is New York Community Bank (NYCB), the fourth largest thrift in the United States, with 143 branches and $24 billion in assets. After a successful 10-branch pilot beginning late last year, the bank announced in February that it will begin distributing and reloading SVCs through its branches. Unlike Central Bank of Kansas City, the New York thrift will not issue the cards or hold the deposits.

Using a specialized POS terminal, the bank will be able to offer Visa-branded gift cards and MasterCard-branded stored value debit cards at the teller window. Purchasing the SVC is a two-step process. Customers first receive a PIN-based card from the teller. A branded card is sent in the mail after customers verify their identity via an 800 number. Once they receive that card, they are free to send the PIN-based card to a friend or family member for funds transfer purposes. The bank is selling the card for $9.95. Reloads cost $3.95 at a NYCB teller window, or $4.95 at GreenDot terminals in retail locations. Direct deposit reloads are free.

According to Marla Knutson, president of the financial institutions division at TransFirst, a processor behind NYCB’s SVC program, “The ultimate goal of this product is for New York Community Bank to provide a service at a lower cost than is presently available to the community it serves. In the long run, the bank hopes to turn unbanked consumers into viable customers, while in the short-term the product enables customers to become familiar with the bank in a way that provides immediate profit potential.”

Banks have a unique opportunity to marry SVCs with higher-margin items like savings products, consumer loans and mortgages that are profitable for both the company and the customer. Such efforts could get a boost from the major credit bureaus, which are considering whether and how customers could build credit through SVC usage.

IMPLEMENTATION ISSUES

But implementing an SVC program is not for the faint of heart. SVCs as a product category didn’t even exist in the U.S. until about 15 years ago, and true general purpose SVCs have been around for only the last few years. General purpose cards, payroll cards and other types of SVCs are usually marketed as separate products. A full range of functionality on a single card is still a new concept, and vendors are just beginning to figure out how to adapt SVCs for lobby use.

Moreover, the economics are complex. Unlike a traditional checking account, where a bank earns a fairly predictable set of monthly fees, SVC revenue generation is less straightforward. Revenues come from activation, maintenance and transaction fees, as well as through interchange fees from merchants and float on the idle funds.

CFSI’s research shows that there is a lack of consensus among leading SVC providers about what makes these products profitable. Interviews with industry leaders suggest near unanimity in the belief that large scale is needed to be profitable, but it is less clear which cost drivers most impact the bottom line.

The lack of consensus about how to establish an ROI explains in part the wide variety of SVC pricing structures. Providers might offer a flat monthly fee with a set number of free transactions, a product that includes only monthly fees with unlimited transactions, or a card that is entirely transaction-based. Moreover, the regulatory landscape surrounding SVCs, particularly the general purpose variety, is still in flux, making it difficult for banks to navigate. The FDIC has yet to rule on whether funds loaded on SVCs are considered “deposits” and would thus qualify for FDIC insurance. The Federal Reserve has proposed that certain SVCs, such as payroll cards, be subject to Regulation E requirements. If adopted, SVC providers could be required to issue statements, raising the cost of what was designed to be a lower-cost alternative. (see “Cards are ‘Just Another’ DDA.”)

PRODUCT ENHANCEMENTS

SVCs need even broader functionality — cash reloads, bill payment, savings and others — to truly substitute for bank accounts and serve as stepping stones to other products and services. Banks are perfectly positioned to offer these benefits, differentiating themselves from earlier entrants, and reaping customer relationship benefits beyond the scope of their alternative competitors.

Ms. Tescher is a director and Ms. Jacob is a senior analyst with The Center for Financial Services innovation, based in Chicago, Ill.

Copyright © 2005 by Banking Strategies, published by BAI.

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